Your company has been approached to bid on a contract to sell 4,000 voice recognition (VR) computer keyboards a year for four years. Due to technological improvements, beyond that time they will be outdated and no sales will be possible. The equipment necessary for the production will cost $3.6 million and will be depreciated on a straight-line basis to a zero salvage value. Production will require an investment in net working capital of $93,000 to be returned at the end of the project, and the equipment can be sold for $273,000 at the end of production. Fixed costs are $638,000 per year, and variable costs are $153 per unit. In addition to the contract, you feel your company can sell 9,300, 10,200, 12,300, and 9,600 additional units to companies in other countries over the next four years, respectively, at a price of $300. This price is fixed. The tax rate is 40 percent, and the required return is 10 percent. Additionally, the president of the company will undertake the project only if it has an NPV of $100,000. What bid price should you set for the contract?
ating bid price
| Market sales | 1 | 2 | 3 | 4 |
| Sales | 2,790,000 | 3,060,000 | 3,690,000 | 2,880,000 |
| Variable costs | 1,422,900 | 1,560,600 | 1,881,900 | 1,468,800 |
| EBT | 1,367,100 | 1,499,400 | 1,808,100 | 1,411,200 |
| TAx (40 %) | 546,840 | 599,760 | 723,240 | 564,480 |
| Net Income (and OCF) | 820260 | 899,640 | 1,084,860 | 846,720 |
| Prrasent value@10% | 745690 | 743504 | 8150751 | 578321 |
| NPV of market sales | 12534717 | |||
| Initial Investment | 3,600-,000 | |||
| Aftertax salvage value | 163800 | |||
| NPV of OCF | 10218266 | |||
| OCF | 175379 | |||
| Bid Price | 246.60 |
You may have noticed that we did not include the initial cash outlay, depreciation, or fixed costs in the calculation of cash flows from the market sales. The reason is that it is irrelevant whether or not we include these here. Remember, we are not only trying to determine the bid price, but we are also determining whether or not the project is feasible. In other words, we are trying to calculate the NPV of the project, not just the NPV of the bid price. We will include these cash flows in the bid price calculation. The reason we stated earlier that whether we included these costs in this initial calculation was irrelevant is that you will come up with the same bid price if you include these costs in this calculation, or if you include them in the bid price calculation.
